Auditor Musical Chairs

On February 5, 2007, the Chairman of the Audit Committee of the Board of Directors (the “Audit Committee”) of BearingPoint, Inc. (the “Company”) was notified by its independent registered public accounting firm, PricewaterhouseCoopers LLP (“PwC”), that PwC is declining to stand for re-election… there were no disagreements between the Company and PwC on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedure…On February 9, 2007, the Audit Committee of the Board of Directors of the Company, as part of its periodic review and corporate governance practices, determined to engage Ernst & Young LLP (“Ernst & Young”) as the Company’s independent registered public accounting firm commencing with the audit for the fiscal year ending December 31, 2007. It is currently anticipated that Ernst & Young will begin providing audit services to the Company immediately.”

Levi Strauss Dumps KPMG as Accountant Feb. 12, 2007 (AFX News Limited) — After years of turmoil, jeans maker Levi Strauss & Co. is dumping KPMG as its independent accounting firm a role that will now be filled by PricewaterhouseCoopers LLC. …wasn’t provoked by any disagreements about accounting principles during Levi’s fiscal 2004 and 2005, according to a Friday filing with the Securities and Exchange Commission.

But a series of accounting blunders that forced Levi’s to restate its financial results over a 2- 1/2 year period earlier this decade raised some tensions. After Levi’s closed the books on its fiscal 2003, KPMG rebuked the company’s management for “material weaknesses in internal controls.” Levi’s replaced its chief financial officer as part of its remedy.”

Change Of Auditors Jan. 29, 2007NORTEL ENGAGES KPMG – The board of Nortel Networks, a designer and marketer of networking solutions for local and long-distance service providers, has selected Big Four firm KPMG as its auditor for its fiscal 2007. KPMG replaces Deloitte & Touche as Nortel’s independent accountant.

CMS DISMISSES E&Y – CMS Energy Corp., a Jackson, Miss.-based electric and natural gas company, dismissed its auditor, Big Four firm Ernst & Young, and named PricewaterhouseCoopers as its new independent accountant.

In a filing, the company said that the change in auditors was the result of a bidding process. CMS reported no disagreements with its former auditor over the past two fiscal years; however, it did note a material weakness in internal controls related to income tax accounting.

CABOT ENGAGES DELOITTE – Chemical and specialty materials holding company Cabot Corp. dismissed auditor PricewaterhouseCoopers and retained Deloitte as its new independent accountant.

The company said that it had no disagreements with PricewaterhouseCoopers, and PwC’s reports on Cabot’s financial statements for the fiscal years ended Sept. 30, 2005 and 2006, did not contain adverse opinions or disclaimers of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles.”

So let me get this straight… Wait a moment, I’m getting dizzy going around in circles… Ok, I’m back. In just the last 10 days, we’ve seen the following changes, amongst others:

BearingPoint, PwC to E&Y
Levi Strauss, KPMG to PwC
CMS Energy, E&Y to PwC
Nortel, Deloitte to KPMG
Cabot Corp, PwC to Deloitte

I have been meaning to write about this post on the Ames Research Group Blog, Professional Services Monitor: Today. I did mention it here, when commenting about E&Y’s seeming comeback from their sanctions. However, my intention was to comment in a broader way on why companies are switching auditors these days and why sometimes the Big 4 firms are ok with that.

In order to do a really good job, supported by super analytics and irrefutable auditor type evidence, I turned to the statistics available on the on-line magazine Compliance Week. There may be better data available via Audit Analytics or at Ames Research Group( too expensive for a poor writer…) or by sitting in the Harold Washington Library Center and perusing Who Audits America (alas, too quickly out of date.)

I like the data on Compliance Week’s site because it’s in Excel format and I can sort and update it easily. So I started looking at the full year 2006 data and was enticed by looking at data all the way back to the end of February 2004. A few challenges with the data:

1) It’s taken from the SEC/Edgar 8-K Wizard tool so there are a lot of duplications based on a separate line for each time a company files an update.
2) Since it reflects each filing, there are a lot of lines where either the incumbent firm or the new firm is “Not Provided.”
3) The reason for change, Dismissed, Resigned, Terminated, etc., is probably a best guess designation by Compliance Week staff and is subjective.

Given these issues, I am not yet ready to give any hard statistics. I expect to clean up the data in the next week and try to have some numbers. However, I’ll make these general observations:

1) As we see above, the movement of large public companies between auditors in the Big 4 is fairly balanced. One or another may be gaining at any one point in time, but with only four key firms, it is hardly ever the case, nor is it feasible, for the client company to conduct a truly competitive “Request for Proposal” process, since one or more of the firms is usually lacking in independence. Most likely, the “auditor-in-waiting” firm has been selected when you see such a quick naming of a new auditor, such as with E&Y in the BearingPoint situation.
2) Very few large (over US$1 billion revenue) companies switch from a next tier or third-tier public accounting firm to a Big 4 firm. This typically happens only if they need a Big 4 firm based on future plans like an IPO or major merger/acquisition. Nobody does it for the status value anymore. This could actually be an indicator for you stock market players…
3) It is expected that sometimes companies will switch from one Big 4 to another for various reasons (see next point…) but these days they’re usually not positive reasons. But it’s almost always for “risk” reasons that a company goes from a Big 4 to a next tier (Grant Thornton, BDO, RSM, etc.) or a third-tier. “Risk” reasons means the Big 4 is shedding the smaller or problematic company from its roster because it has become too insolent and risky. This does not bode well for the level of supervision that will be needed for the non-Big 4 firms if this trend continues.
4) The standard SEC filing (8-K) for a Big 4 to Big 4 switch inevitably says there are “no disagreements.” But in many cases, especially now, companies are being dropped, in my estimation, because they have either used their last favor or are on the verge of becoming bankrupt (and so one firm hands off the next round to another in order to “ring fence” potential liability/litigation) or the company is refusing to heed the advice of their auditor to get their act together. Sometimes the company thinks and can get a more favorable hearing from a firm that isn’t tainted by having been involved in blessing the issues now in dispute for too long but is now is saying, “no more.” In other words, it is rarely nowadays a bad thing for the outgoing firm to “lose” these types of clients. They’re really just shifting the risks around to each and perhaps diluting them in the process…

If a firm like PwC is losing market share, per the Ames Research Group study, it is probably, in my opinion, because they are choosing to shed risky (for them) clients or are making a conscious, strategic decision to do consulting work instead of audit work for a particular company. Don’t ever think that the audit firms are surprised very often by these changes. It is often their doing and everyone puts on a stone face in order to save face and stave off litigation. It would be impossible, under the current business circumstances (except in the most unusual situations such as adversarial litigation or major malfeasance by the auditor,) for any company to both surprise their current auditor and engage their new auditor on a moment’s notice. The world is just too complex…

Which begs the questions – How much discussion between the firms occurs under these circumstances? Why does it seem that, in the end, it all works out for the best, with no hard feelings?

More later…

5 replies
  1. PSMToday
    PSMToday says:

    A few notes, observations and concurrences with your post.

    As you say, searching for auditor changes on 8Ks is not as simple as it may seem. This is often the case with SEC filing regulations versus what is actually practiced. While a company must disclose when it dismisses or otherwise parts ways with its current auditor, companies are not required, to the best of our knowledge, to file when they engage a new auditor. Thus, 10% to 20% of 8Ks are incomplete. Also, companies often file auditor-change 8Ks as part of being acquired. For example, the larger Company Z acquires Company A, and thus, Company A becomes audited by Company Z’s firm. This is important for Company A’s shareholders to know. However, from the perspective of the auditor, this scenario is much different than a normal auditor change, despite the similar reporting method. Tracking auditor changes has many other nuances, but these two examples illustrate the need for critical, human review of each case in order to have a definitive data product on auditor changes. Taking the automated approach will come to perhaps a 75% accuracy rate, at best.

    Regarding competitiveness, one cannot argue there is a limited field from which to choose. However, we find that nearly 60% of auditor changes involve at least two firms proposing for the work.

    Looking at auditor changes on an annual basis, the Big Four firms have collectively had a net loss in public company audit clients every year since 2003. In 2002, they enjoyed large gains but only at the expense of Andersen. Going farther back, only Ernst & Young had a net gain in 2001. The firms will say that this is largely due to “strategic exits,” that is, resigning from risky audit engagements. During 2003 and 2004, even into 2005, this explanation makes sense. The firms began to take a hard look at the clients they took on from Andersen. The full impact of SOX 404 takes hold at company and auditor alike, both realizing they lack the necessary resources. And so, the Big Four began assessing their audit clients for risk in a new way, resigning from engagements deemed risky in relatively large numbers. Firms also left relatively unprofitable engagements to rally the resources needed to handle the 404 workload at their largest clients.

    Again, this process makes sense when looking at 2004, and 2003 and 2005 to lesser extent. One can observe the same pattern at each Big Four firm during that time. However, since mid-2005, we have observed a turn-around at two of the Big Four. Deloitte and Ernst & Young have significantly narrowed their net loss due to auditor changes. More importantly, both firms have actually gained clients in the largest segment of companies we track. PricewaterhouseCoopers, on the other hand, continues to have a large net loss, and its losses are greatest at the large-company level. Furthermore, we find that PwC is being invited to propose at about the same rate as the other Big Four, but is converting invitations to engagements at a rate far below its competitors.

    You also raise the question of what happened to all of these companies deemed too risky to audit by the Big Four. They went to the second-tier firms—BDO, Grant Thornton and McGladrey. These are good, high-quality organizations. However, they are orders of magnitude smaller than the Big Four. During the 2003-2005 window mentioned above, companies were throwing themselves at the second and third-tier audit firms, hundreds of companies. Some, not all, were those risky companies, clients that needed time and resources to be served properly. At the same time, the second and third-tier firms faced off against the Big Four in trying to add qualified people from the same talent pool.

    Looking at the situation from a distance, it seems precarious for the second and third-tier firms: A large influx of clients, in a 18 to 24-month period, some of whom were deemed risky by the Big Four, while competing heavily for new people, and trying to implement new SOX regulations. Fortunately, nothing dire has happened here.

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